Monday, September 28, 2015

Why QE, particularly QE 3, was contractory.

It all comes down to this. To have an expanding economy you have to have
an EXPANDING MONEY SUPPLY and or EXPANDING MONEY VELOCITY, which is turnover of the money stock.

The structure of our Central Bank system (CB) is that the
non-banks (NB) are the customers of the CB.
The member banks of the CB are the intermediaries between the NBs and
the CB. NBs include you and me. They also include the repo and wholesale bank
funding markets.

The intermediaries, the banks, having been flooded with
QE money, stopped needing to borrow overnight.
The repo market participants were not needed as much and their profits
dried up. Same with money market funds
that provide short term funding to the intermediaries which killed off their
profits too.

>meaning that
the velocity of money from these participants dropped<

Now for you and me.
Lower interest rates was the goal of QE which was to spur lending. But lower interest rates for seniors caused a
fall of income and they reduced their spending.
People saving for retirement increased their savings if they could, to
make up for the loss of growth in their retirement funds. Credit card rates did not go down and thus
spending via credit card debt slowed down.

>meaning
that the velocity of money from these participants dropped<

Bank lending is what increases the money supply. The CB forcibly took interest bearing bonds
away from the banks and replaced them with cash that paid a paltry .25%. Banks, which are the intermediaries between
the NBs and the CB, were supposed to lend more because they had all this
cash. But instead, the banks focused on
spread management. They didn’t think
that lending more at low interest rate was a good idea as it reduced their
spread between their cost of money and the interest income they could get,
their profit margin. They did have to
reduce rates to their top corporate customers and lend them whatever they
wanted. For the rest, it resulted in:

>reduced interest in borrowing /
reduced level of lending, which reduced the growth of the
money supply<

Notice that even with QE 1, there was an upturn in
anticipation of ending QE 1.

During QE 2, there was a down turn. But notice that there was an upturn in
anticipation of QE 2 ending.

QE 3 was anticipated and started a down turn in
anticipation of it. During QE 3 there
was a decline.

Then the taper.
This was a yearlong period, 2014, that anticipated the end of QE.

The money supply skyrocketed at the end of QE 2. The anticipation of and QE 3 was a disaster
in terms of increasing the growth of the money supply. Only the taper leveled things out.

Money velocity had already turned down due to
increasingly lower interest rates. Look
how incredibly steep the turnover of money drops during the QE years when they
dropped interest rates so low for the non-banks, which include you and me.

In summary, both money supply growth slowed due to less lending, and money
velocity declined from the NBs, the non banks. The exact opposite of
what was desired.